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- Title
Budget deficits and real interest rates: a regime-switching reflection on Ricardian Equivalence.
- Authors
Choi, Daniel; Holmes, Mark
- Abstract
This paper investigates the relevance of the Ricardian Equivalence theorem for the relationship between the budget deficit and real interest rate. In contrast to the existing literature, we focus on regime-change over a long study period and consider nonlinearities. Using a Markov regime-switching model applied to two centuries of annual data, we find evidence that the US economy switches between a Ricardian Equivalence regime, characterized by an insignificant relationship between the adjusted primary budget deficit and real long-term interest rate, and a regime characterized by the traditional view of a positive relationship. We also find evidence that the transition probabilities between regimes are time-varying insofar as a weaker level of economic activity, a lower real interest rate differential between the US and abroad, or higher national debts, is associated with a weaker relationship between budget deficits and interest rates.
- Subjects
BUDGET deficits; INTEREST rates; REGIME change; RICARDIAN equivalence theorem; NONLINEAR theories; MARKOV processes; PUBLIC debts
- Publication
Journal of Economics & Finance, 2014, Vol 38, Issue 1, p71
- ISSN
1055-0925
- Publication type
Article
- DOI
10.1007/s12197-011-9212-9